Roth IRA question


I

iarwain

In these unstable, hard economic times, I would like to expand my
liquid assets. Having a six month emergency fund doesn't make me feel
particularlly comfortable anymore. I have a Roth IRA, but I am
depending mainly on other accounts for retirement. In an emergency
situation, I'm thinking I could cash in the Roth IRA. Here's my
question:

I've already paid taxes on the money I put into the Roth. I am in my
early 50s. If i cash this out early, am I going to have to pay taxes
on all this money AGAIN, plus pay a 10% penalty. Or do I only pay
taxes on any interest earned? And does the 10% penalty apply to the
whole amount or just the interest?

If I have to pay taxes on the whole amount, I must say that seems
rather unfair.
 
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J

JoeTaxpayer

In these unstable, hard economic times, I would like to expand my
liquid assets. Having a six month emergency fund doesn't make me feel
particularly comfortable anymore. I have a Roth IRA, but I am
depending mainly on other accounts for retirement. In an emergency
situation, I'm thinking I could cash in the Roth IRA. Here's my
question:

I've already paid taxes on the money I put into the Roth. I am in my
early 50s. If i cash this out early, am I going to have to pay taxes
on all this money AGAIN, plus pay a 10% penalty. Or do I only pay
taxes on any interest earned? And does the 10% penalty apply to the
whole amount or just the interest?

If I have to pay taxes on the whole amount, I must say that seems
rather unfair.
Indeed, deposits may come out tax free/ penalty free any time. This
opens the possibility to treat the Roth as a secondary emergency fund if
your retirement is funded elsewhere. Gains are taxed and 10% penalty if
not 59.5.
 
R

Rich Carreiro

iarwain said:
I've already paid taxes on the money I put into the Roth. I am in my
early 50s. If i cash this out early, am I going to have to pay taxes
on all this money AGAIN, plus pay a 10% penalty. Or do I only pay
taxes on any interest earned? And does the 10% penalty apply to the
whole amount or just the interest?
The money you *contributed* comes out tax-free and penalty-free.

The money, if any, that you converted from a traditional IRA to
a Roth IRA comes out tax-free. If it has been more than 5 years
since you made the conversion, money from *that* conversion also fomes
out penalty-free.

Any earnings will be subject to both income tax and the 10%
early withdrawal penalty (unless you meet one of the exceptions,
like using it to pay certain medical expenses of more than a
certain amount).

And unlike trad IRA distributions which follow a pro-ration rule,
Roth distributions follow a specific order:
* First your contributions are deemed to come out.
* Then your conversions are deemed to come out, in the order
they were made.
* Then your earnings are deemed to come out.

This is all explained further in IRS Pub 590.
 
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